Bankruptcy May Spur New Federal Controls : Investments: Treasury official predicts regulations on sales to public agencies of securities that led to O.C. losses.

Signaling a more activist federal response to problems underscored by Orange County’s financial collapse, Deputy Treasury Secretary Frank N. Newman said Tuesday that regulators are likely to adopt tough new controls on the sales practices of the brokers and bankers who market the complex financial instruments that contributed to the county’s woes.

Newman said federal agencies are particularly concerned whether public agencies are being sold investments that are inappropriate for their investment portfolios.

“You will see more coming out about sales practices and suitability,” Newman told a meeting of the Government Finance Officers Assn.

Top federal officials had previously declared the Orange County bankruptcy a local problem with little impact on the nation’s financial markets.

In other developments Tuesday:

* Gov. Pete Wilson, in Washington, vowed that California will not allow any Orange County school to close its doors. But Wilson said any funds redirected to county school districts left financially crippled by their investments in the county pool would be in the form of loans that would have to be repaid.

“We have to assure that the kids are educated,” Wilson said, noting a 1992 state Supreme Court decision that declared the state responsible for providing students with an education. “We are empowered to impose on them an arrangement whereby they repay the state,” Wilson said after a meeting at the National Governors Assn. “Because in effect what we are doing is borrowing from other school districts, which is not fair . . . when they have engaged in financially irresponsible conduct.”

* About 200 parents and students gathered in Santa Ana, cheering and applauding as one speaker after another demanded that the county return 100% of school money frozen in the depleted county investment pool.

“We have one, single message,” said Fran Williams, a parent and teacher at Rancho Santiago College. “Dinero! Ahora! (Money! Now! ) “

“I’d rather have bad roads than crowded classrooms,” said Mark Perew, a Santa Ana parent who helped organize the rally. “I’d rather have libraries open for our kids to be in than more cops to arrest our kids.”

* Former Orange County Rep. William E. Dannemeyer held a news conference to demand that the county immediately float new bonds to resolve its nearly 2-month - old bankruptcy and finance the payments by slashing salaries of all public employees by 10% to 15%.

Accompanied by a loose coalition of conservative county organizations under the title “Californians for America,” Dannemeyer also warned that any elected official who raises “taxes, fees or assessments” would be promptly targeted for removal from office.

“We’re putting any elected public official on notice that if any of them vote to raise taxes or fees of any kind whatsoever . . . we will assist in recalling them,” he said, “whether they serve on a school board, a water district or a city council.”

* County officials said they would offer to rehire 39 of the 152 people who were given pink slips earlier this month. The move came in response to an order from U.S. Bankruptcy Judge John E. Ryan that the county consider seniority rights of employees when making cutbacks.

County officials and labor leaders are scheduled to return to court Thursday to report on their progress. “We’ve done what the judge has asked us to do,” said Charles Axelrod, an attorney working for the county. “We’ve sat down and met and conferred with each bargaining group and have had philosophical meetings with the coalition of labor groups.”

Axelrod said the 39 terminated employees would “either get their old job back or have the right to bump to a lower position,” and that the county might be able to accommodate those changes without laying off 39 other employees.

Cynthia Pickett, field organizer for the Service Employees International Union, said she is “pretty satisfied” with the new deal. But John H. Sawyer, general manager of the Orange County Employees Assn., said he still has significant disagreements with the county over both short- and long-term layoffs.

“Our proposal is that we stay with the labor agreements that we have with the county,” said Sawyer, whose group represents 11,000 of the county’s 18,000 workers. “It’s been in place for 25 years. We think the county should live with it.”

* Ryan also imposed guidelines on members of two committees of county creditors to prevent them from profiting from insider information while working with the county and creditors to resolve the county’s bankruptcy. The committees are a subcommittee of those who hold Orange County-backed bonds and on the official committee of unsecured creditors.

Several members of the committees, including Franklin Advisors, Kemper Financial Advisors, Putnam Investments and the Benham Group, are large financial institutions that hold county securities.

* The Orange County Employees Retirement System scheduled a Thursday morning meeting to discuss possible litigation against the county. Board members are angry that some of the retirement system’s money is trapped in the county’s investment pool and cannot be used to pay retirees as of today. The agency said it had to dip into reserves to pay retirees.

* Officials said all spring sports will continue as planned throughout Orange County high schools.

“We’ve received a firm commitment from the Orange County schools that the spring sports will not be cut,” said Dean Crowley, Southern Section commissioner of the California Interscholastic Federation, which governs high school sports. He added that it is unclear how the crisis will affect sport programs during the 1995-96 school year.

In Washington, Newman--the deputy treasury secretary--urged local government officials to acquire a better understanding of the products being marketed by the nation’s investment houses. He also endorsed the idea of a voluntary model investment code for cities and counties.

“You need to understand the instruments you are using,” Newman told an audience that included state and local investment officers.

Newman heads a special working group of federal agencies--created after the 1987 stock market crash--that is scrutinizing how derivative securities and other complicated financial instruments are marketed.

The participating agencies include the Securities and Exchange Commission and the Commodity Futures Trading Commission, which are expected to develop new rules for brokerage and trading firms. Three bank regulatory agencies--the Federal Reserve Board, the Comptroller of the Currency and the Federal Deposit Insurance Corp.--could develop restrictions on the conduct of banks involved in selling complex financial instruments to local governments.

Federal officials emphasize that they have no blanket objection to the use of derivatives--instruments whose value is linked to changes in interest rates or other economic indicators. Nor are they upset with leverage--that is, borrowing money to take a larger position in the market. Both are acceptable and routine tools of money managers in corporations as well as governments.

But former Orange County Treasurer-Tax Collector Robert L. Citron has been blamed for betting too heavily on one side of the ledger, investing in derivatives whose value was linked to declining interest rates. And he leveraged a $7-billion portfolio of public funds into what became a $20-billion bet on interest rates. When interest rates began rising last year, Orange County suffered a loss of $1.69 billion on the value of its portfolio.

The federal government continues to steer clear of any legislative proposals that would deeply involve Washington in the issuance of securities by thousands of cities, counties, school districts and other local agencies.

That would interfere with the roles of state and local governments, Newman said, and would require adding thousands of new federal workers if, for instance, the SEC were to review the prospectuses for local bond offerings as it does for corporate stock sales.

“It is not the role of the federal government to protect market participants from the prospect they might lose money,” Newman told the finance officers.

Meanwhile, Wilson’s statement in Washington on Tuesday was his most detailed discussion yet of how the state might have to help rescue Orange County from its ongoing financial mess.

In his State of the State speech earlier this month, Wilson took note of the county’s crisis but offered no hint of a bailout, instead suggesting that lawmakers tighten the rules on municipal investing so “high-risk gambling” with taxpayer dollars does not happen again. But from the beginning, Wilson has acknowledged that the state had a special responsibility to local schools.

Wilson said Tuesday that the state is required to step in and run local schools rather than let them shut down, regardless of what causes their financial problems. In the case of a state takeover, he said, the state would make all financial and management decisions for the local schools. He said the assistance would come from other areas of the state budget and would be loans, not handouts.

“They are required to repay what is, in effect, an advance required to keep the school doors open,” Wilson said.

Orange County’s 31 school districts had more than $1.1 billion tied up in the Orange County treasury. Districts are required by law to funnel virtually all their funds through the county, treating it like a bank. Most also placed borrowed funds in the treasury as a routine part of operations.

Five education agencies also took the unprecedented step starting in 1993 of borrowing large sums for the sole purpose of reaping profits through the investment pool, a move Wilson has previously likened to “taking the milk money and playing bingo with it.”

Tuesday, the governor reiterated his distaste for the prospect of bailing out Orange County schools, but said the state would have no choice if the schools run out of money.

Asked how the state would fund a special bailout for schools that faced bankruptcy, Wilson said: “That’s exactly why we have raised so much hell. It has to come from something else, which is really not fair. And the reason for that is education is the priority.”

Wilson and Maureen DiMarco, the governor’s secretary for child welfare and education, both emphasized that if the state were forced to take over Orange County schools, the help would come in the form of loans.

“This is not a blanket promise that the governor is going to come in with the state’s checkbook, which I might remind you has a low balance, and write a check,” DiMarco said.

John Nelson of the Orange County Department of Education said a state takeover would be “devastating” for local schools and the county overall.

“School districts in Orange County have been governed and managed extremely well,” said Nelson, who represents the schools on the bankruptcy creditors committee. “To paint our districts in the same light as districts that had those problems where the state had to come in, it would be a major problem to overcome. It would affect property values of everybody in Orange County. It would be very, very costly.”

Rosenblatt reported from Washington and Wilgoren from Orange County. Times staff writers Mark Platte, J.R. Moehringer, Lee Romney and Susan Marquez Owen in Orange County and Dave Lesher in Washington contributed to this report.